Should you use fixed pricing in valuation provisions in a shareholder’s agreement?

Valuation provisions are the heart of a shareholders’ agreement. The parties must agree to the circumstances and pricing for any transfer of shares.

Yet, the valuation provisions are the most difficult clauses to draft.

These provisions are often a wellspring of shareholder disputes and complex litigation. Any ambiguity or uncertainty in the valuation provisions is an opening for a court or complaining shareholder to dispute the valuation. Compare, e.g, Lyon v. Sanger, 107 N.Y.S.2d 300 (Sup. Ct. Special Term N.Y. Cnty. 1951) (court abided by shareholders’ agreement which explicitly listed the dollar figure to be used in valuation) with Pedersen v. Royce, 38 A.D.3d 1090, 831 N.Y.S.2d 607(3d Dep’t 2007) (court engaged in fact finding and credibility determination re value of stock).

One solution to this challenge is to use fixed pricing in valuation provisions. The fixed pricing could be an actual dollar figure, tied to an insurance policy benefit amount, or related to periodic valuations.

The advantage of using fixed pricing is clarity and certainty - - there can be no ambiguity as to what the price is. Each one of the parties knows exactly what the value of their shares is and will be and there is no room for court interpretation.

But even with the lure of the simplicity of fixed pricing in valuation provisions, there are many counterbalancing considerations against using them.

First, the fixed pricing may have little relation to the fair market value of the stock; as a value fixed in time, the stock’s appreciation or depreciation will not be considered. Long time shareholders that have weathered the ups and downs of the business may want to be paid the true value of their stock rather than a fixed price.

Second, fixed pricing that is dependent on an insurance policy may be ill advised - - what if the policy is not purchased, lapses, or does not pay out? In the absence of the policy payment, there may be no payment or no funding for the transfer of shares.

Lastly, fixed pricing based on periodic valuations seems to combine the worst of all worlds. It still requires an actual valuation to be done - - defeating the clarity and certainty goal - - and may still result in pricing unrelated to the fair market value if the valuation is not done in a timely manner.

So while the allure of fixed pricing in shareholder valuation provisions is appealing, it may just be a mirage that one must pass by.

For more information about this article or other issues, please contact us The Bachman Law Firm PLLC at judith@thebachmanlawfirm.com or 845-639-3210.